CH 7

CHAPTER 7
Revealed Preference
Copyright © 2019 Hal R. Varian

Revealed Preference Analysis
Suppose we observe the demands (consumption choices) that a consumer
makes for different budgets. This reveals information about the consumer’s
preferences. We can use this information to . . .
• test the behavioral hypothesis that a consumer chooses the most
preferred bundle from those available.
• discover the consumer’s preference relation.

Assumptions on Preferences – 1
Preferences
• do not change while the choice data are gathered.
• are strictly convex.
• are monotonic.
Together, convexity and monotonicity imply that the most preferred affordable
bundle is unique.

Assumptions on Preferences – 2

Direct Preference Revelation – 1
Suppose that the bundle x* is chosen when the bundle y is affordable. Then x*
is directly revealed preferred (DRP) to y (otherwise y would have been
chosen).
Revealed preference is a relation that holds between the bundle that is actually demanded at some
budget and the bundles that could have been demanded at that budget.


That x is revealed directly as preferred to y will be written as x > y.
The Principle of Revealed Preference. Let (x1, x2) be the chosen bundle when prices are
(p1, p2), and let (y1, y2) be some other bundle such that p1x1 +p2x2 ≥ p1y1 +p2y2.
Then if the consumer is choosing the most preferred bundle she can afford, we must
have (x1, x2) ≻ (y1, y2).

Indirect Preference Revelation – 1
Suppose x is directly revealed preferred to y, and y directly revealed preferred
to z. Then, by transitivity, x is indirectly revealed preferred (IRP) to z. In
symbols,
If x > y and y > z, then x > z.
Or equivalently, if x DRP y and y DRP z, then x IRP z.
The “chain” of observed choices may be longer than just three: if bundle A is directly revealed preferred to
B, and B to C, and C to D, . . . all the way to M, say, then bundle A is still indirectly revealed preferred to M.
The chain of direct comparisons can be of any length.




Two Axioms of Revealed Preference
To apply revealed preference analysis, choices must satisfy two criteria—the
Weak and the Strong Axioms of Revealed Preference.

The Weak Axiom of Revealed Preference (WARP) – 1
If the bundle x is revealed directly as preferred to the bundle y then it is
never the case that y is revealed directly as preferred to x;
i.e., if x DRP y, then y CANNOT BE DRP x.

The Weak Axiom of Revealed Preference (WARP) – 2
A person that makes choices in violation of the WARP is inconsistent with
economic rationality.
The WARP is a necessary condition for applying economic rationality to
explain observed choices.

A Violation of WARP
This behavioral inconsistency is problematic. If we witness this for a consumer, we really

can’t make sense of his/her underlying preferences.
Checking if Data Violate the WARP – 1
A consumer makes the following choices:
• At prices the choice was
Is the WARP violated by these data?

the choice was This choice cost the consumer
• Could be afforded?
So, (5, 5) was affordable while (10, 1) was chosen. (10, 1) DRP (5, 5).
So, (5, 4) was affordable while (10, 1) was chosen. (10, 1) DRP (5, 4).

• At the choice was This choice cost the consumer
So, (10,1) was unaffordable while (5,5) was chosen.
So, (5, 4) was affordable while (5,5) was chosen. (5,5) DRP (5, 4).

• At the choice was This choice cost the consumer
• Could Be afforded?
was unaffordable while (5,4) was chosen.
• Could Be afforded?
was affordable while (5,4) was chosen. (5,4) DRP (10,1).
This is a violation of the WARP. This consumer’s behavior is inconsistent.

In summary,
• (10, 1) DRP (5, 5)
• (10, 1) DRP (5, 4)
• (5, 5) DRP (5, 4)
• (5, 4) DRP (10, 1)
But, the WARP states that it cannot be that both (10, 1) DRP (5, 4) and
(5, 4) DRP (10, 1).

The Strong Axiom of Revealed Preference (SARP) – 1
If the bundle x is revealed preferred (directly or indirectly) to the bundle y
and x  y, then it is never the case that the y is revealed preferred (directly or
indirectly) to x.
If the observed behavior is optimizing behavior then it must satisfy the SARP

Checking if Data Violate the WARP
Choices
(10, 1) (5, 5) (5, 4)
Prices
($2, $2) $22 $20 $18
($2, $1) $21 $15 $14
($1, $2) $12 $15 $13

Choices
(10, 1) (5, 5) (5, 4)
Prices
($2, $2) $22 $20 $18
($2, $1) $21 $15 $14
($1, $2) $12 $15 $13
Red numbers are costs of chosen bundles.

Choices
(10, 1) (5, 5) (5, 4)
Prices
($2, $2) $22 $20 $18
($2, $1) $21 $15 $14
($1, $2) $12 $15 $13
Circles surround affordable bundles that

were not chosen.
Choices
(10, 1) (5, 5) (5, 4)
Prices
($2, $2) $22 $20 $18
($2, $1) $21 $15 $14
($1, $2) $12 $15 $13

were not chosen.
Choices
(10, 1) (5, 5) (5, 4)
Prices
($2, $2) $22 $20 $18
($2, $1) $21 $15 $14
($1, $2) $12 $15 $13

were not chosen.
Ch o i c e s
(10,1) (5,5) (5,4) (10, 1) (5, 5) (5, 4)
Prices
($2,$2) $22 $20 $18 (10,1) D D
($2,$1) $21 $15 $14 (5, 5) D
($1,$2) $12 $15 $13 (5 ,4) D

Ch o i c e s
(10,1) (5,5) (5,4) (10, 1) (5, 5) (5, 4)
Prices
($2,$2) $22 $20 $18 (10,1) D D
($2,$1) $21 $15 $14 (5, 5) D
($1,$2) $12 $15 $13 (5 ,4) D

(10,1) is directly (10, 1) (5, 5) (5, 4)

revealed preferred
to (5,4), but (5,4) is (10,1) D D
directly revealed
preferred to (10,1), (5, 5) D
so the WARP is
violated by the data. (5 ,4) D
x2
(5,4)
p (10,1)
D
(10,1)
p (5,4)
D
x1
The Strong Axiom of Revealed Preference (SARP) – 2
That the observed choice data satisfy the SARP is both a necessary and
sufficient condition for there to be a well-behaved preference relation that
“rationalizes” the data.
In other words, if the SARP is not violated, the behavior is considered rational.

The Strong Axiom of Revealed Preference
u What choice data would satisfy the WARP but
violate the SARP?
u Consider the following data:
A: (p1,p2,p3) = (1,3,10) & (x1,x2,x3) = (3,1,4)
B: (p1,p2,p3) = (4,3,6) & (x1,x2,x3) = (2,5,3)
C: (p1,p2,p3) = (1,1,5) & (x1,x2,x3) = (4,4,3)

A: ($1,$3,$10)
Choice
(3,1,4). Prices
A B C
B: ($4,$3,$6) A $46 $47 $46

(2,5,3).
B $39 $41 $46
C: ($1,$1,$5) C $24 $22 $23

(4,4,3).
Choices
A B C
Prices
A $46 $47 $46
B $39 $41 $46
C $24 $22 $23

Choices In situation A,
A B C
Prices bundle A is
directly revealed
A $46 $47 $46
preferred to
bundle C;
B $39 $41 $46 p
A C.
D
C $24 $22 $23
Choices In situation B,
A B C
Prices bundle B is
directly revealed
A $46 $47 $46
preferred to
bundle A;
B $39 $41 $46 p
B A.
D
C $24 $22 $23
Choices In situation C,
A B C
Prices bundle C is
directly revealed
A $46 $47 $46
preferred to
bundle B;
B $39 $41 $46 p
C B.
D
C $24 $22 $23
Choices
A B C A B C
Prices
A $46 $47 $46 A D
B $39 $41 $46 B D
C $24 $22 $23 C D

Choices
A B C A B C
Prices
A $46 $47 $46 A D
B $39 $41 $46 B D
C $24 $22 $23 C D
The data do not violate the WARP.

We have that A B C
p p p
A C, B A and C B A D
D D D
so, by transitivity, B D
p p p
A B, B C and C A. C D
I I I
The data do not violate the WARP but ...

We have that A B C
p p p
A C, B A and C B A I D
D D D
so, by transitivity, B D I
p p p
A B, B C and C A. C I D
I I I

p
B A is inconsistent A B C
D
p
with A B. A I D
I
B D I
C I D

p
A C is inconsistent A B C
D
p
with C A. A I D
I
B D I
C I D

p
C B is inconsistent A B C
D
p
with B C. A I D
I
B D I
C I D

A B C
The data do not violate
the WARP but there are A I D
3 violations of the SARP.
B D I
C I D
Recovering Indifference Curves
Suppose we have the choice data satisfy the SARP.
Then we can discover approximately where are the consumer’s indifference
curves.

Suppose we have the choice data satisfy the
SARP.
Then we can discover approximately where are the
consumer’s indifference curves.
How?
u Suppose we observe:
A: (p1,p2) = ($1,$1) & (x1,x2) = (15,15)
B: (p1,p2) = ($2,$1) & (x1,x2) = (10,20)
C: (p1,p2) = ($1,$2) & (x1,x2) = (20,10)
D: (p1,p2) = ($2,$5) & (x1,x2) = (30,12)
E: (p1,p2) = ($5,$2) & (x1,x2) = (12,30).
u Where lies the indifference curve containing the
bundle A = (15,15)?
u Indirect preference revelations add no extra
information, so the table showing both direct and
indirect preference revelations is the same as the
table showing only the direct preference
revelations:
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15)
B: (p1,p2)=(2,1); (x1,x2)=(10,20)
E C: (p1,p2)=(1,2); (x1,x2)=(20,10)
D: (p1,p2)=(2,5); (x1,x2)=(30,12)
B E: (p1,p2)=(5,2); (x1,x2)=(12,30).
D
A C
x1
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15)
B: (p1,p2)=(2,1); (x1,x2)=(10,20)
E C: (p1,p2)=(1,2); (x1,x2)=(20,10)
D: (p1,p2)=(2,5); (x1,x2)=(30,12)
B E: (p1,p2)=(5,2); (x1,x2)=(12,30).
D
A C
x1
Begin with bundles revealed
to be less preferred than bundle A.
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15).
x1
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15).
x1
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15).
A is directly revealed preferred

to any bundle in
x1
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15)
B: (p1,p2)=(2,1); (x1,x2)=(10,20).
E
D
A C
x1
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15)
B: (p1,p2)=(2,1); (x1,x2)=(10,20).
x1
x2
A is directly revealed preferred
to B and …
x1
x2
B is directly revealed preferred
to all bundles in
B
x1
x2
so, by transitivity, A is indirectly
revealed preferred to all bundles
in
B
x1
x2
so A is now revealed preferred
to all bundles in the union.
B
A
x1
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15)
E C: (p1,p2)=(1,2); (x1,x2)=(20,10).
D
A C
x1
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15)
C: (p1,p2)=(1,2); (x1,x2)=(20,10).
A C
x1
x2 A is directly revealed
preferred to C and ...
A C
x1
x2 C is directly revealed preferred
to all bundles in
x1
x2 so, by transitivity, A is
indirectly revealed preferred
to all bundles in
x1
x2 so A is now revealed preferred
B
A
C
x1
x2 so A is now revealed preferred
Therefore the indifference
curve containing A must lie
B
everywhere else above
A this shaded set.
C
x1
Now, what about the bundles revealed as more
preferred than A?
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15)
B: (p1,p2)=(2,1); (x1,x2)=(10,20)
E C: (p1,p2)=(1,2); (x1,x2)=(20,10)
D: (p1,p2)=(2,5); (x1,x2)=(30,12)
B E: (p1,p2)=(5,2); (x1,x2)=(12,30).
A
D
A C
x1
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15)
D: (p1,p2)=(2,5); (x1,x2)=(30,12).
A
D
x1
x2 D is directly revealed preferred
to A.
A
D
x1
to A.
Well-behaved preferences are
convex
A
D
x1
to A.
convex so all bundles on the
line between A and D are
A
preferred to A also.
D
x1
to A.
line between A and D are
A
D
As well, ...
x1
x2 all bundles containing the
same amount of commodity 2
and more of commodity 1 than
D are preferred to D and
therefore are preferred to A
A also.
D
x1
x2
bundles revealed to be
strictly preferred to A
A
D
x1
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15)
B: (p1,p2)=(2,1); (x1,x2)=(10,20)
E C: (p1,p2)=(1,2); (x1,x2)=(20,10)
D: (p1,p2)=(2,5); (x1,x2)=(30,12)
B E: (p1,p2)=(5,2); (x1,x2)=(12,30).
A
D
A C
x1
x2 A: (p1,p2)=(1,1); (x1,x2)=(15,15)
E: (p1,p2)=(5,2); (x1,x2)=(12,30).
x1
x2
E is directly revealed preferred
to A.
E
x1
x2
to A.
E Well-behaved preferences are
convex
x1
x2
to A.
line between A and E are
A
x1
x2
to A.
line between A and E are
A
As well, ...
x1
x2 all bundles containing the
same amount of commodity 1
and more of commodity 2 than
E E are preferred to E and
therefore are preferred to A
also.
A
x1
x2
More bundles revealed
E to be strictly preferred
to A
x1
x2
Bundles revealed
E earlier as preferred
to A
B
A C
D
x1
x2
All bundles revealed

E to be preferred to A
B
A
C
D
x1
Now we have upper and lower bounds on where
the indifference curve containing bundle A may lie.
x2

to be preferred to A
x1
All bundles revealed to be less preferred to A
x2

to be preferred to A
x1
All bundles revealed to be less preferred to A
x2
The region in which the
indifference curve containing
bundle A must lie.
x1
Index Numbers – 1
Over time, many prices change. Are consumers better or worse off “overall” as
a consequence?
Index numbers give approximate answers to such questions.

Index Numbers – 2
Two basic types of indices:
• price indices
• quantity indices
Each index compares expenditures in a base period and in a current period
by taking the ratio of expenditures.

Quantity Index Numbers – 1
A quantity index is a price-weighted average of quantities demanded; i.e.,
(p1, p2) can be base period prices (p1b, p2b) or current period prices (p1t, p2t).

If then we have the Laspeyres quantity index:

If then we have the Paasche quantity index:

How can quantity indices be used to make statements about changes in
welfare?

If then
so consumers overall were better off in the base period than they are now in
the current period.

Price Index Numbers – 1
A price index is a quantity-weighted average of prices; i.e., (x1, x2) can be the
base period bundle (x1b, x2b) or else the current period bundle (x1t, x2t).
If we use the base period prices for the weights, we have something called a Laspeyres index, and if we use
the t period prices, we have something called a Paasche index.
Both of these indices answer the question of what has happened to “average” consumption, but they just use
different weights in the averaging process.

If then we have the Laspeyres price index:

If then we have the Paasche price index:

How can price indices be used to make statements about changes in welfare?
Define the expenditure ratio

If , then
so consumers overall are better off in the current period.

But, if then
so consumers overall were better off in the base period.

Credits
This concludes the Lecture PowerPoint presentation for Chapter 7 of Intermediate Microeconomics, 9e.
For more resources, please visit http://digital.wwnorton.com/intermicro9media.

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CHAPTER 7

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

This behavioral inconsistency is problematic. If we witness this for a consumer, we really

A consumer makes the following choices:

• At prices the choice was

• At prices the choice was

• At prices the choice was

Is the WARP violated by these data?

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

• At the choice was This choice cost the consumer

This is a violation of the WARP. This consumer’s behavior is inconsistent.

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

($2, $1) $21 $15 $14

($1, $2) $12 $15 $13

($2, $1) $21 $15 $14

($1, $2) $12 $15 $13

Red numbers are costs of chosen bundles.

($2, $1) $21 $15 $14

($1, $2) $12 $15 $13

Circles surround affordable bundles that

($2, $1) $21 $15 $14

($1, $2) $12 $15 $13

Circles surround affordable bundles that

($2, $1) $21 $15 $14

($1, $2) $12 $15 $13

Circles surround affordable bundles that

($2,$1) $21 $15 $14 (5, 5) D

($1,$2) $12 $15 $13 (5 ,4) D

($2,$1) $21 $15 $14 (5, 5) D

($1,$2) $12 $15 $13 (5 ,4) D

(10,1) is directly (10, 1) (5, 5) (5, 4)

Copyright © 2019 Hal R. Varian

A: (p1,p2,p3) = (1,3,10) & (x1,x2,x3) = (3,1,4)

B: (p1,p2,p3) = (4,3,6) & (x1,x2,x3) = (2,5,3)

C: (p1,p2,p3) = (1,1,5) & (x1,x2,x3) = (4,4,3)

B: ($4,$3,$6) A $46 $47 $46

C: ($1,$1,$5) C $24 $22 $23

B $39 $41 $46

C $24 $22 $23

B $39 $41 $46 B D

C $24 $22 $23 C D